Wharton’s Howard Kunreuther discusses his report on the insurance industry surrounding catastrophic events.
Hurricane Matthew wreaked havoc in Haiti before causing massive damage to parts of the southeastern United States earlier this year. In the Carolinas, flooding damage from the storm was assessed at more than $1 billion. Insurance against a catastrophic event, such as a hurricane or earthquake, often is not purchased by consumers or purchased too late. The most common reason is that homeowners believe the odds are stacked in their favor. Howard Kunreuther, Wharton professor of operations, information and decisions and co-director of the Wharton Risk Management and Decision Processes Center, put together a report that looks at the insurance industry surrounding catastrophic events. He recently appeared on the [email protected] show, part of Wharton Business Radio on SiriusXM channel 111 to talk about what can be done to improve coverage and minimize risks.
An edited transcript of the conversation follows.
[email protected]: Why do so many homeowners and business owners not purchase insurance against catastrophic events?
[email protected]: A lot of people figured Florida’s eastern coast was going to get hit hard by Matthew. It did suffer damage, but not as much as a lot of people thought. North Carolina ended up being the focus, and there was flooding far inland where many people wouldn’t even consider this type of insurance.
Kunreuther: That’s exactly right. One of the real challenges is that there are areas that are affected that are not classified as being high-hazard areas, flood-prone areas. They are not required to buy flood insurance and, in many cases, people have no idea that they could have damage from something like a hurricane. There are also areas like Baton Rouge, Louisiana, that are inland that had a storm surge and heavy rainfall. Pensacola, Florida, had that in 2014, and Baton Rouge had it this past August. Very few people in these areas have flood insurance for two reasons: They didn’t expect it, and they are not required to buy it. If you have a federally insured mortgage and you’re in a high hazard zone, a zone that is classified as a special flood hazard area, you have to buy it. Many people still don’t or it’s not fully enforced. But if you’re not in that area, you don’t have to buy it, and people will think that they’re safe.
[email protected]: That’s a state-to-state decision, correct?
Kunreuther: No, that’s a federal decision. That’s the National Flood Insurance Program, which is what markets that policy.
One area that I want to mention right away is the importance of having accurate mapping. The Federal Emergency Management Agency is working on that. I’m on the Technical Mapping Advisory Committee, just for full disclosure, where we’ve been talking about the fact that FEMA is really working hard to get maps that are better designed to let people know what the hazard is, and to communicate the risk in a way that is not the case today.
[email protected]: There are coastal areas in Louisiana and Florida where the water level is changing. It could be vastly different in 10 years. Even doing the mapping now, you are doing it knowing that there will be changes within the next decade?
“It’s extremely hard to let people know that the best return on an insurance policy is no return.”
Kunreuther: I think that’s right. The first step is to get the mapping now. Let’s put that on the table and get good maps now. The second step — and it has to come as quickly as one can do that — is to recognize that with climate change and other factors, the maps may change. You want to at least recognize sea level rise as a real issue that has to be considered, that we need to pay attention if you’re going to be designing new homes, to recognize that they will have to meet some of the problems in the future that we don’t have right now.
[email protected]: For people who live near water or could be in the path of a storm, is the insurance affordable?
Kunreuther: This is a major question. I am glad you brought it up because in the issues brief that I recently wrote and other work that our Wharton Risk Center has been doing, we raise the issue of affordability right at the outset. There are two principles that I think need to be considered when you’re dealing with insurance to make it acceptable, both in terms of communicating the risk and dealing with the equity and affordability issue. Insurance premiums should reflect risk. If you have a premium that reflects risk and you let everyone know “this is what your insurance premium should be,” you give people information that they otherwise wouldn’t have. And if you subsidize the premium right at the outset and never tell them what a risk-based premium is, they’re never going to know and they’re going to think they’re a lot safer than they actually are. That’s one reason.
The other reason is that if you tell them, “Look, there are things that you can do to reduce your insurance premium and reduce your risk, and that is to make your house safer.” In some cases, you can elevate; in other cases, you can flood-proof. A risk-based premium would go way down if it turns out that you will take those steps. But if that’s all you say and you’re raising the question of affordability, you really are dead in many ways before you get started.
You really have to address the issue of equity and affordability. We feel very strongly about that in our risk center and our work that we are doing. I personally feel, after having interviewed a number of low-income people in Pensacola, that if we don’t deal with that issue, we are doing an injustice at a very broad level. The view that we have taken is that you have to somehow deal with this, but you shouldn’t deal with it with an insurance premium. You should deal with it in other ways. We deal with it in our society today with food stamps and vouchers. What we’re suggesting is to give them a voucher. It’s saying, “If your premium is very high because it’s risk-based now, we’ll help you out. But at the same time, what we would like to have you consider is mitigate and make your house safer. And if you mitigate and make your house safer, the premium is